Investment Perspectives Volume 13, No. 1 – June 2017

“The minute you get away from the fundamentals – whether it’s proper technique, work ethic, or mental preparation – the bottom can fall out of your game.”

–Michael Jordan, Basketball Hall of Famer

A Mixed Bag – But Momentum Remains

The momentum building in the latter part of 2016 carried through into the first half of 2017. Investors’ confidence in the Trump rally held; with the promise of tax cuts, infrastructure spending, and financial industry deregulation ringing true. Energy, banks, and industrial stocks set to benefit from this proposed agenda saw particular strength as investors aimed to quickly cash in.

But as time passed a miasma of controversies--real or imagined—surrounded the new U.S. administration. The political gridlock has slowed the President’s ability to deliver on his promises, adding market uncertainty. The so called Trump trade has been unwinding, although, for now, it has not stopped equities from performing well.

The backstop for U.S. equities has been the continued improvement of economic conditions in 2017. Real progress was made like adding 1.3 million full-time jobs in the first five months of the year. With a tightening labour market wage growth has ensued. Much of this good news appears to be priced in as the S&P 500 Index hit its record high in June. But there’s downside comfort given that upwards earning revisions for S&P companies have been the most widespread in three years.

The Canadian markets were hampered by challenges in the energy and material sectors, with spill over onto the banks. Not all is bad at home; however, as Canada’s economy is also showing signs of life. Corporate profits are near levels not seen since 2014 and nominal gross domestic product has expanded at more than 7% annualized for three consecutive quarters. Better profits have led to sizeable increases in the full-time employment numbers for prime-aged workers, seeing the best run in two decades.

Markets and their underlying economies don’t necessarily move in sync. Emotions, risk perceptions, uncertainties and animal spirits are equally at play in day-to-day stock prices. Mental preparation for us includes recalling the great investment analyst Benjamin Graham’s keen insight, “In the short run, the market is a voting machine but in the long run, it is a weighing machine.” In frothy markets our disciplined research focus is on bottom-up corporate fundamentals. Our sole intention is to own sustainable, growing businesses that produce satisfactory long-term returns for you.

As always, we thank you for your support and continued confidence in WDS.

Equities:

Canadian markets had a slow start to 2017, with oil-price weakness and overall sluggish performance muting the enthusiasm from last year’s dynamic recovery. The S&P/TSX Composite Index ($TSX) ended the first half of 2017 down 0.7 per cent, a sub-par performance among country benchmarks. Taking dividends into account the TSX returned a positive 0.7 per cent (total return). The result was largely driven by energy, which fell a whopping 13.3 per cent (total return). Interestingly, despite an expected Canadian interest rate hike, traditional interest-sensitive sectors like utilities and telecom actually outperformed financials, entering the second half of the year with a total return of 10.08 per cent and 7.58 per cent, respectively, while financials earned 2.55 per cent on the same basis.

Despite the media’s blitz of controversies surrounding the Trump administration, U.S. markets outperformed Canada handily, owing in part to their lower exposure to the energy industry. The S&P 500 Index ($SPX) reached an all-time high in June, with eight of the eleven major U.S. sectors setting records. The index earned 9.5 per cent (U$) total return for the first six months of 2017, though strength in our loonie lowered that to 5.4 per cent in Canadian-dollar terms.

Europe had an eventful start, which markets shrugged off. Britain’s snap election eliminated Prime Minister Theresa May’s parliamentary majority, weakening her government’s Brexit plans. Conversely France’s new president Emmanuel Macron signalled renewed commitment to the European Union. Italy’s government approved an unpopular bailout for its banks to restore stability. Despite these uncertainties, the Eurozone outlook has improved since 2016. Overall global markets, proxied by the MSCI EAFE Index ($MSEAFE), were up 16.0 per cent (U$) year-to-date on a total return basis, with Emerging Asia and Europe leading the charge.

Fixed income and interest rates:

Oil prices fell to their lowest level since August 2016. Canada’s trade deficit increased to $1.09 billion in May 2017, despite exports hitting a record high. Nonetheless the Bank of Canada indicated its intent to increase its key interest rate, a first move since 2010. The domestic yield curve acted accordingly, shifting upward with 2-year and 10-year Government of Canada benchmark bonds moving higher to 1.10 per cent and 1.77 per cent, respectively.

The U.S. Federal Reserve had two rate hikes this year, first to 1.0 per cent in March and then to 1.25 per cent in June. The U.S. yield curve flattened slightly in response, with the 2-year U.S. benchmark bond increasing to 1.38 per cent and the 10-year decreasing to 2.31 per cent.

Source: Bloomberg Finance L.P.

Currencies:

The Canadian dollar ended the first half of 2017 in the green -- after a drop below $0.73 in May -- closing June at $0.77 per U.S. dollar, up 3.4 per cent year-to-date. Strength in the dollar has largely been attributed to the anticipated interest rate hike, while a slight recovery in oil prices from their June low supported the uptick.

Even so the Canadian dollar remains relatively cheap, enabling Canada’s exports to reach record highs this year. Typically, a lower dollar correlates to more export activity and fewer imports, as foreign goods become more expensive and Canadian goods become less so. Interesting, though, our country’s trade deficit actually doubled by May, as imports grew at almost twice the rate of exports. Stranger still this occurred during the same month the Canadian dollar fell to its lowest point. This import-surge anomaly was related to large purchases of foreign transportation equipment and parts.

Commodities:

West Texas Intermediate ($WTIC) light crude oil ended 2016 at US$53.72 per barrel and stayed close to this level until March. The price then fluctuated before ending June at US$46.04 per barrel, down 14.3 per cent. Many energy analysts blamed oversupply for the retrenchment, an ongoing issue despite OPEC extending its production cut in May.

Gold closed 2016 at US$1,152 per ounce, off the higher levels enjoyed throughout most of last year. Gold acts as a safe haven with prices trending higher in uncertain times. With rising geopolitical tensions and rancour about Trump’s White House, 2017 saw gold up moderately, closing US$1,242 ($GOLD). It’s a solid recovery yet the precious metal remains below the higher levels reached in 2016.

This report is provided for your information. Conclusions and opinions given do not guarantee future events or performance. Facts and data provided are from sources we believe to be reliable, but we cannot guarantee they are complete or accurate. This report is not to be construed as an offer to sell or a solicitation of an offer to buy any securities. Before making an investment or adopting an investment strategy, each investor should review his investment objectives with their investment advisor. Watson Di Primio Steel (WDS) Investment Management Ltd. and individuals and companies who are related may, at any time, buy or sell securities that are hereby described in this report.

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